Inheritance vs. Gift: Tax Implications CPAs Must Know for Client Advice

Neither a gift nor an inheritance triggers federal income tax for the recipient at the moment of transfer — there is no line on Form 1040 for "I received a $500,000 house from my parents." The critical tax question is not what happens when the client receives the asset, but what basis they take, what that means when they eventually sell it, and — for the donor side — whether gift tax or estate tax applies. Understanding the three-way distinction between carryover basis (gifts), stepped-up basis (inherited assets), and income in respect of a decedent (inherited retirement accounts) is the foundation for any advice involving wealth transfers between generations.

The Core Rule: No Federal Income Tax on Receipt

When a client receives an inheritance from a decedent's estate or a gift from a living donor, the receipt itself is not includible in the client's gross income under IRC §102(a). This exclusion covers cash, property, and any form of gratuitous transfer.

There are two important exceptions:

• Income earned on gifted or inherited property after the transfer is taxable in the ordinary course — interest, dividends, rental income, and business profits generated from the asset after receipt are fully taxable to the new owner.
• Income in Respect of a Decedent (IRD) items — income that was earned or accrued by the decedent before death but not yet received — do not receive the §102 exclusion. IRD is discussed separately below.

The donor side of the transaction is a separate analysis. A donor who gives appreciated property does not recognize gain at the time of the gift under IRC §1001 principles (see Taft v. Bowers, 278 U.S. 470 (1929)), but the gift may trigger gift tax reporting obligations.

Inherited Property: Stepped-Up Basis Under IRC §1014

The most valuable tax feature of inheritance is the step-up in basis to fair market value at the decedent's date of death under IRC §1014(a). A client who inherits stock worth $800,000 that the decedent purchased for $80,000 takes a new basis of $800,000 — the $720,000 of unrealized gain accumulated during the decedent's lifetime disappears permanently. No capital gains tax is owed by the estate, the heir, or anyone else on that appreciation.

Equally important: under IRC §1223(9), an heir is automatically treated as having held any inherited capital asset long-term, regardless of how long the decedent held it or how quickly the heir sells. An heir who sells inherited stock the week after receiving it pays long-term capital gains rates (0%, 15%, or 20% depending on income) rather than short-term ordinary income rates. For 2025 LTCG rate thresholds, see Short-Term vs Long-Term Capital Gains Tax Rates 2025.

The §1014 step-up applies to property included in the decedent's gross estate — individually owned capital assets, assets in revocable living trusts (IRC §2038), and community property in the nine community property states. In community property states, both spouses' shares of community property receive a step-up at the first death (IRC §1014(b)(6)), not just the deceased spouse's share.

Assets that do NOT receive a step-up are primarily IRD items, lifetime gifts completed before death, and assets removed from the taxable estate through irrevocable trusts. For the complete §1014 analysis — including the §754 election for partnership interests, alternate valuation date, and planning strategies — see Step-Up in Basis at Death (IRC §1014): Tax Planning Guide for CPAs.

Gifted Property: Carryover Basis Under IRC §1015

When a living donor transfers property by gift, the recipient takes the donor's adjusted basis — no step-up occurs. Under IRC §1015(a), the recipient's gain basis equals the donor's basis at the time of the gift. If the donor paid gift tax on the transfer, the recipient can increase the basis by the amount of gift tax attributable to the net appreciation in the property at the time of the gift (IRC §1015(d)(6)).

The loss rule is a trap CPAs must address. If the property's FMV at the time of the gift is less than the donor's adjusted basis, the recipient uses different bases for gain and loss calculations:

• Gain basis: the donor's original adjusted basis
• Loss basis: FMV at the time of the gift

If the recipient sells the property at a price between those two numbers, no gain or loss is recognized. This rule (IRC §1015(a)) prevents donors from transferring built-in losses to recipients in higher brackets.

Holding period: For purposes of the capital gains long-term/short-term determination, the recipient adds the donor's holding period to their own — so a recipient who immediately sells a gift held by the donor for two years recognizes a long-term capital gain. This tack-on applies only when the recipient's gain basis is the donor's carryover basis (i.e., when the property was not worth less than the donor's basis at the time of the gift).

Gift Tax Rules: Annual Exclusion, Lifetime Exemption, and Form 709

The gift tax (IRC §§2501–2524) is a transfer tax imposed on the donor — not the recipient. Clients who ask whether they owe taxes on a gift they received should understand that if any gift tax is owed, it falls on the giver.

Annual exclusion. Under IRC §2503(b), a donor can give up to $19,000 per recipient per year in 2025 (indexed for inflation; $18,000 for 2024) completely free of gift tax and with no reporting requirement. Married couples can elect gift-splitting under IRC §2513, effectively doubling the annual exclusion to $38,000 per recipient — but a Form 709 must be filed to make the election even if no tax is due.

Lifetime exemption. Each individual has a unified credit that effectively shelters $13.99 million (2025, indexed) of cumulative taxable gifts (gifts exceeding the annual exclusion) and/or taxable estate from federal gift and estate tax (IRC §2505, §2010). Gifts above the annual exclusion reduce the remaining lifetime exemption dollar-for-dollar. The 40% federal gift and estate tax rate applies only to amounts above the exemption.

Form 709 filing. A donor must file Form 709 (U.S. Gift and Generation-Skipping Transfer Tax Return) for any calendar year in which they:

• Make gifts to any single recipient exceeding the $19,000 annual exclusion
• Elect gift-splitting with a spouse
• Make gifts to a trust or of a future interest (which never qualifies for the annual exclusion regardless of amount)
• Make a direct skip subject to generation-skipping transfer (GST) tax

Form 709 is due April 15 of the year following the gift, with an automatic extension to October 15 if the donor files for an extension of their individual income tax return. There is no extension to pay any gift tax owed — only the extension to file. The statute of limitations on gift tax does not begin to run until a Form 709 is filed, which is a significant long-term risk CPAs should flag for clients who have made large gifts without filing.

Income in Respect of a Decedent: The Major Exception for Retirement Accounts

The single most important "inheritance" question CPAs field involves traditional IRAs and 401(k) plans: clients who inherit retirement accounts do NOT receive a basis step-up. These accounts are Income in Respect of a Decedent (IRD) under IRC §691 — the income was earned by the decedent before death but deferred; when the beneficiary receives distributions, those distributions are fully taxable as ordinary income.

Common IRD items inherited beneficiaries must report:

• Traditional IRA, SEP-IRA, and SIMPLE IRA distributions (fully taxable)
• 401(k), 403(b), and 457(b) plan distributions (fully taxable)
• Deferred compensation payments not received before death
• Accrued interest, wages, and accounts receivable of cash-basis businesses
• The gain portion of installment sale receivables

Under the SECURE 2.0 Act (enacted December 2022), most non-spouse beneficiaries are subject to the 10-year rule: the account must be fully distributed within 10 years of the decedent's death, with no required minimum distributions during those 10 years for most beneficiaries (IRS final regulations under IRC §401(a)(9) have clarified specific rules for "eligible designated beneficiaries"). Eligible designated beneficiaries — surviving spouses, minor children, chronically ill or disabled individuals, and beneficiaries not more than 10 years younger than the decedent — retain the right to stretch distributions over their life expectancy.

The IRD deduction. Under IRC §691(c), a beneficiary can deduct the federal estate tax attributable to the IRD item, computed as a proportion of total estate tax paid on the estate. This deduction is claimed as a miscellaneous itemized deduction on Schedule A (not subject to the 2% floor) and partially offsets — but does not eliminate — the income tax on IRD.

State Inheritance Taxes: Six States Still Tax Beneficiaries

Federal law imposes no inheritance tax; only the estate pays federal estate tax (if the estate exceeds the exemption). But six states impose a state-level inheritance tax on the beneficiary:

Iowa is phasing out its inheritance tax, with complete repeal effective for decedents dying on or after January 1, 2025. Maryland is notable for imposing both a state estate tax (estates over ~$5 million) and a state inheritance tax. CPAs advising clients with beneficiaries in these states must account for state inheritance tax in their analysis, separate from any federal estate tax calculation.

Planning Frameworks: When to Gift vs. When to Hold Until Death

The central planning question is whether a client should transfer appreciated assets by gift now or hold until death. The answer depends on the relationship between the basis step-up benefit and the gift tax / estate tax exposure:

Scenario 1 — Hold appreciated assets, never gift them. For appreciated property (FMV > adjusted basis), dying with the asset is almost always superior to gifting it during life. The heir receives a stepped-up basis and avoids capital gains tax on all appreciation. The only exceptions: (a) gifting to a donee in the 0% long-term capital gains bracket who will sell immediately, capturing the current 0% rate; or (b) extreme estate tax exposure where removing the asset from the estate reduces a 40% estate tax bill by more than the lost step-up saves.

Scenario 2 — Gift assets with built-in losses. For depreciated property (FMV < adjusted basis), the client should sell the asset before death to recognize the deductible capital loss — dying with a depreciated asset causes a step-down in basis to FMV, permanently eliminating the tax loss. After selling and recognizing the loss, the after-tax proceeds can be gifted.

Scenario 3 — Annual exclusion gifting for estate reduction. Clients with estates approaching or above the federal exemption threshold should consider systematic annual exclusion gifting ($19,000 per recipient per year in 2025). These gifts remove assets — and all future appreciation — from the taxable estate without triggering gift tax or using any lifetime exemption. A couple with four children and four spouses-of-children can gift $304,000 per year ($38,000 × 8) with gift-splitting, completely free of gift tax and reporting, while steadily reducing the taxable estate.

Scenario 4 — 529 superfunding. Under IRC §529(c)(2), a donor can front-load five years of annual exclusion contributions into a 529 plan in a single year ($95,000 per beneficiary in 2025, or $190,000 per couple with gift-splitting). The donor reports this on Form 709 making the five-year election, and no additional annual exclusion gifts to that beneficiary may be made during the five-year period.

Scenario 5 — Trump Account contributions for newborns. For children born after OBBBA's enactment, contributions to a Trump Account (Money Account for Growth and Advancement) count as completed gifts and qualify for the annual exclusion. The account accepts up to $5,000 per year from all contributors combined. Unlike 529 plans, Trump Accounts do not permit 5-year superfunding, but the mandatory Roth IRA rollover at age 30 makes them highly tax-efficient vehicles for early-life wealth transfers. CPAs coordinating multi-generational gifting strategies should map Trump Account contributions alongside 529 and UTMA contributions against the annual exclusion budget. See our full CPA guide to Trump Accounts for contribution rules and gift tax interaction.

Frequently Asked Questions

Does an inheritance count as income on my tax return?

No. Under IRC §102(a), inheritances are excluded from gross income and are not reportable as income on Form 1040. The amount you receive — whether cash, stock, or real property — does not appear on your tax return. However, income the inherited property generates after you receive it (interest, dividends, rental income) is fully taxable to you.

Do I owe taxes when I receive a gift?

No. The recipient of a gift owes no federal income tax or gift tax on the receipt. If any gift tax is owed, it is the donor's obligation. You do not even need to report receiving a gift on your tax return. However, your basis in the gifted property is the donor's basis (carryover basis), which affects the tax you owe when you eventually sell the property.

What is the gift tax annual exclusion for 2025?

For 2025, each donor can give up to $19,000 per recipient per year without triggering any gift tax or filing requirement (IRS Rev. Proc. 2024-40; IRC §2503(b)). This exclusion is per-recipient, so a donor can give $19,000 each to 10 different people — $190,000 total — with no gift tax consequence. Married couples who elect gift-splitting on Form 709 can effectively double this to $38,000 per recipient.

What happens to an inherited IRA or 401(k) — is it tax-free?

No. Inherited retirement accounts such as traditional IRAs and 401(k)s are Income in Respect of a Decedent (IRD) under IRC §691. There is no step-up in basis. Every dollar distributed from an inherited IRA or 401(k) is taxable to the beneficiary as ordinary income in the year received. For most non-spouse beneficiaries, SECURE 2.0 requires the entire account to be distributed within 10 years of the decedent's death.

Do I need to file any tax forms when I inherit property?

Generally, no. Receiving an inheritance does not require filing a return or form. However, if you inherit through an estate that files a return (Form 1041), you may receive a Schedule K-1 reporting income that passed through to you during estate administration. Additionally, once you sell inherited property, you'll report the sale on Schedule D using your stepped-up basis — you'll need documentation of the property's FMV at the decedent's date of death, typically from an appraisal or estate records.

Are there state inheritance taxes I need to worry about?

Six states — Iowa (phasing out), Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania — impose a state-level inheritance tax on beneficiaries. Rates and exemptions vary by the beneficiary's relationship to the decedent; surviving spouses are typically exempt in all six. These are entirely separate from the federal estate tax, which is paid by the estate (not the beneficiaries) and only applies to estates above the federal exemption (~$13.99 million in 2025).

What is the "basis" I receive when inheriting stock vs. receiving it as a gift?

For inherited stock: your basis is the fair market value on the decedent's date of death (the stepped-up basis under IRC §1014). If you sell immediately, there is no capital gains tax. For gifted stock: your basis is the donor's original cost basis carried over to you under IRC §1015. If you sell, you recognize a capital gain measured from that original cost — all appreciation during the donor's lifetime becomes your taxable gain.

How do I advise a client on whether to gift assets now or hold until death?

The general rule: hold appreciated assets until death so heirs receive a stepped-up basis, and give away assets expected to appreciate significantly in the future (to remove future growth from the taxable estate while using the annual exclusion or lifetime exemption). For clients with estates below the federal exemption, the step-up is almost always more valuable than any gift tax benefit. For clients with estates well above the exemption, aggressive gifting strategies may be warranted even at the cost of the step-up. For the full CPA planning framework — OBBBA's $15M exemption mechanics, portability elections, advanced trust structures (GRATs, SLATs), state estate tax exposure, and the step-up break-even calculation — see Estate and Gift Tax Planning Under the OBBBA $15M Exemption.

Arvori helps CPAs manage the workflow behind estate and gift tax planning — including tracking client basis history, flagging IRD items in inherited accounts, and coordinating with insurance brokers on key person and buy-sell coverage that intersects with estate plans. Learn more at arvori.app.